Choosing the Right Business Entity

Three Considerations for Choosing a Business Entity

There are many reasons why you might choose one type of business entity over another type of entity. However, there are three basic considerations that every business owner should weigh carefully when choosing a business entity.

• Ease of Formation — How difficult is it to set up the business entity? Some business structures are more difficult, time-consuming, and costly compared to other entities.

• Liability Protection — As a business owner, you must consider your personal assets when choosing a business structure. You might need the increased personal liability protection offered by an LLP or an LLC instead of a sole proprietorship.

• Tax Implications — Each business structure has tax implications for the business income and your personal Choosing the wrong business entity can increase your tax obligations.

It is crucial that each factor is considered carefully before choosing a business structure. In some cases, more weight must be given to one factor because of your personal circumstances. An experienced business transaction attorney can help you determine which of the business entities provide you with the most protection and benefits with the least disadvantages.

Common Types of Business Structures for Maryland, Virginia, and Washington DC Companies

Several types of business entities exist for you to choose from when organizing your business structure. Each structure has pros and cons associated with choosing that type of business entity. The key is to choose the structure that gives you the best benefits based on your goals and your business. Choosing the incorrect type of business structure can result in limited growth, additional taxes, and legal and financial liability.

Common types of business structures many owners choose include:

Sole Proprietorship

Many small businesses begin as a sole proprietorship, even if they later decide to change the structure of the business. A sole proprietor does business under his or her name without creating a separate legal entity for the business. Some owners use a DBA or “doing business as” designation without taking steps to set up a DBA properly.

The main benefit of a sole proprietorship is that it does not require any legal filings to create, nor does it involve ongoing legal filings. You do not need to file a separate tax return for the business, and all profits pass directly to the owner. However, the significant disadvantage of this type of business entity is that you have an elevated liability risk. You are personally liable for all business debts, in addition to the legal liability if someone was to sue you for breach of contract, an injury, or other legal issues. Therefore, your personal assets can be at risk if you are a sole proprietor.

Partnerships

Limited liability partnerships (LLPs) and general partnerships are used when more than one person owns the business. A general partnership has the same disadvantages as a sole proprietorship because all partners share in the liabilities of the company. The law assumes that the owners are equally liable unless the written partnership agreement states otherwise. Therefore, many people choose to form an LLP instead of a general partnership.

An LLP can shield the owner’s personal assets from liability for company debts and legal problems. Another benefit of forming an LLP is that profits pass through the LLP to the owners so that the income is taxed at the owners’ individual tax rates. In theory, the LLP agreement sets forth how decisions are made so that the company can operate smoothly without crippling disputes.

However, an LLP has several disadvantages. For example, if you want to change any of the partnership terms or add a partner, you must conduct a formal meeting to change the partnership agreement. In addition, an LLP must be maintained very carefully, and it must file separate tax returns. Annual meetings and detailed records are required. If the LLP is not maintained properly, creditors and others might be able to attack the partners’ personal assets to satisfy partnership debts and liabilities.

Limited Liability Companies

Limited liability companies (LLCs) are a popular business structure for small and medium-sized businesses. An operating agreement sets forth the terms and conditions of how the business will operate. Owners of the business are referred to as members. Members can be individuals or other business entities. You may have a single member LLC or a multiple member LLC.

There are several advantages of an LLC. LLCs are easy to set up, and the operating agreement allows for great flexibility in how the business is managed or operated. An LLC operating agreement allows for almost any type of internal organization that the members desire.

Members are shielded from liability, provided the LLC is maintained properly. However, some lenders will not extend credit to an LLC without personal guarantees from the members, which creates personal liability for the members for that debt. As with LLPs, an LLC must be maintained, file tax returns, and maintain detailed records or the members may not continue to benefit from the business structure.

Corporations

Corporations provide the most structure and protection for business owners. This type of business entity usually requires the most work to set up and maintain. However, it also provides the most protection for shareholders (owners) from personal liability for company debts and legal problems. S Corporations are used for businesses that have 100 or fewer shareholders. Shareholders enjoy the tax advantage of a pass-through business entity without the risk of liability associated with other business entities.

However, being designated as an S Corporation can limit the growth of the company. As with all corporations, you must have a structured board to oversee operations and hold annual shareholder meetings. Failing to maintain the corporation correctly could result in significant liability and tax issues for shareholders.

For larger corporations, a C Corporation is the usual business structure chosen for operating purposes. Profits are subject to corporate income tax before they are paid to shareholders. Therefore, C Corporations face a double-taxation scenario that LLPs and LLCs do not face. C Corporations can be expensive to set up and maintain; however, they may be necessary for large businesses with significant cash flow and assets.

Do You Need Help Choosing the Right Business Entity?

Experienced business contract lawyer Steve Thienel can help business owners throughout Washington DC, Virginia, and Maryland in choosing the right business entity. Call now to learn more about protecting everything you have worked so hard to build.